Monday 10 December 2012

Thoughts on RMG Factory Fires

Tuesday, December 11, 2012

Thoughts on factory fires

The recent tragic incident of factory fire in Ashulia has elevated long and widely held concerns about workplace safety in the RMG sector of Bangladesh. The purpose of this commentary is to explore the risks of such fatal events and how best to manage those risks.

Ashulia-like factory fires belong to the class of low frequency and high severity (LF-HS) operational risk events like earthquakes, hurricanes and terrorist attacks that can cause severe loss of life and damage to physical assets. They do not occur that commonly, but the consequences are fatal if and when they occur. In contrast, events such as mechanical failures, power outages, and work related injuries for individual workers are more commonplace but the consequences are not as severe.

Businesses typically manage operational risk in two principal manners. First, an operational risk control system is established to lower the chances of these events occurring in the first place and to reduce their potential severity. An operational risk committee oversees this process of measuring the risk on an ongoing basis, instituting physical measures and managerial action plans and controls, and monitoring the readiness and effectiveness of the overall risk control system. Second, since LF-HS events may still take place, businesses also purchase operational risk insurance to withstand such losses. Additionally, they often allocate and maintain operational risk capital as a buffer. The operational risk insurance and capital are funded solely by the business, and are different from work related compensation plans that cover contingencies (like accidental death or dismemberment) that are more commonplace, limited to one or at most a few employees in any one such event, and the employees typically contribute to such a plan.

Let us now review the Ashulia factory fire (AFF) from the above operational risk management perspective.

With more than 110 lives lost, the AFF is clearly one of the highest severity events in the worldwide RMG industry. According to Nilratan Halder (Financial Express, December 1, 2012), more than 200 people died over the last six years in Bangladesh and there were about 1,300 incidents in RMG factory fires. J. Ahmed and T. Hossain (Sri Lankan Journal of Management 14(1)) say that 263 people died in 9 RMG factory fires during 2001-2006. In contrast, factory fires are virtually non-existent in the RMG factories elsewhere including Vietnam and Nepal. Thus, the Bangladesh experience presents a lethal and uncommon combination of high frequency and high severity RMG factory fires. There is little doubt that this is primarily due to the lack of proper safety measures at the factories and the lax nature of enforcement of the mandatory safety standards by the government. In other words, prudent risk control, physical as well as managerial (RMG owners and related government agencies), is grossly inadequate.

While the nation and the families of the perished AFF workers grapple with the tragedy, the need for a national policy on operational risk control at RMG factories can hardly be overemphasised. A national policy should start with creating a National Operational Risk Board (NORB) with representation from the Parliament, related government ministries/agencies, RMG owners, foreign RMG clients, the RMG workforce, and home and foreign experts on operational risk management.

In addition to revisiting and resetting the proper safety standards, the NORB should set up the requirements of a mandatory operational risk control system at each RMG firm as well as at each factory that should be externally audited semi-annually if not quarterly by domestic and/or foreign firms qualified to do so. Much like the auditing of financial statements, no RMG firm or factory should be allowed to operate without due clearance from the external auditors as well as the NORB. NORB should also have a sub-committee responsible for developing and overseeing a plan of coordination and integration of the role and responsibilities of the pertinent government agencies including the areas of power, fire, water, labour, civil construction, roads and highways, health and medical services, and law enforcement.

While comprehensive and effective operational risk control is imperative in reducing the frequency and potential severity of factory fires, a fatal event like the AFF may still occur despite the best efforts. A principal concern in the aftermath of events like the AFF is adequate and immediate compensation for the families of the workers lost or injured. This purpose can be served well by the mandatory purchase of operational risk insurance and maintenance of a minimum amount of operational risk capital at the owner firms, both funded by the owner firm. To address moral hazard on the part of the owners, such operational risk insurance should have claim payout only to the families of workers (and not to the firm or its shareholders, creditors or clients) and the speedy disbursements of such funds should be overseen by the NORB.

To ensure compliance in this regard, forced reserving may be useful, whereby the Bangladesh Bank will withhold a sufficient amount of export revenue of an owner firm to pay for its operational risk insurance and to maintain the minimum operational risk capital. Since export revenues may be realised in creative ways, Bangladesh Bank should readily communicate to the NORB about any shortfall of required funds, and the NORB should then suspend the operations of a factory if the owner remains delinquent.

To conclude, as the nation grapples with the tragedy in the garment factory, it is important that a comprehensive national operational risk control policy and an operational risk insurance/capital programme are put in place as promptly as possible. This should lessen the exposure of the all important RMG sector to the high frequency high severity factory fires that continue to claim the lives of many workers, and could also materially hurt the vital export revenue due to client concerns about working conditions at the factories.

The writer is a Professor of Practice in Finance at McGill University, Montreal, Canada.



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